Life Insurance Product Overview

There are two types of life insurance; term and cash value policies. Term insurance simply provides death protection. If the insured dies during the policy period, the beneficiaries receive the amount of coverage purchased. In contrast, cash value policies bundle death protection and savings accumulation. When purchasing a cash value policies bundle death protection and savings accumulation. When purchasing a cash value life insurance policy, a person essentially is both purchasing death protection and saving money with the insurance company. The amount of savings accumulated is called the policy’s cash value. As discussed further below, policyholders can withdraw or alter the savings accumulations from cash value life insurance policies in various ways.

The most common types of cash value policies are whole life, universal life and variable life. With whole life policies, the schedule of cash values over time is fixed at the time the policy is purchased. Implicit in this schedule of cash values are returns earned on the savings that are accumulated within the policy. The implicit returns on a whole life policy generally are not reported to the policyholder and no attempt is made to unbundle the death protection from the savings accumulation. Under modern variations of cash value life insurance however the separation of the death protection and savings accumulation are made more transparent to the policyholder.

Also instead of having a fixed schedule of cash values the cash cash can vary with current interest rates, the return earned on the insurer’s entire assert portfolio or the return on specific portfolios of investments such as stock mutual funds. As a result, universal and variable life often are called investment sensitive contracts.

Policyholders are entitled to at least a portion of a policy’s cash value if they surrender the policy. Early policy surrenders are called lapses. With universal life and variable life policies a surrender charges typically decrease with the number of years that the policy is in force. With whole life, explicit surrender charges are not used and the policy’s cash surrender value each year equals the predetermined cash value. However, the predetermined schedule of cash values reflects implicit surrender charges the early years surrender value each year equals the predetermined cash value. However,they predetermined schedule of cash values reflects implicit surrender charges during the early years of the policy, which makes the implicit return earned on the policy savings low if the policy is surrendered after only several years.

Why would a person wish to bundle death protection coverage with savings accumulation in a life insurance contract ? One reason is that people desire permanent life insurance protection and for budgeting purposes they prefer to pay for this protection using a level premium over time. As will become clearer later, paying for permanent death protection using a level premium automatically gives rise to a cash value that increases over time. In other words, the savings accumulation is byproduct of a fundamental desire for permanent life insurance and level premiums . Perhaps a mmore important reason for bundling death protection and savings accumulation is that there are tax advantages of saving with a life insurance policy, which we will analyze below.

One disadvantage of saving through life insurance for some persons is that death protection also must purchased to achieve these tax advantages. In addition, the transactions costs included in cash value policies, especially if the savings are withdrawn early. In some cases, tax penalties also can be applied if the policy is surrendered early.

When discussing life insurance policies, several terms can cause confusion. The death benefit is the a;mount of money that the beneficiaries receive from the insurer when the insured dies. As previously described, the cash value is the amount of savings accumulation from the policy. For term insurance, whole life insurance and some types of universal life insurance the death benefit equals the policy’s face amount, which is the stated amount of coverage purchased by the policyholder.

However, for some types of universal life policies, the death benefit equals the face amount plus the cash value. Death protection is the amount of pure death protection coverage provided by the policy. The amount of death protection equals the death benefit minus the cash value.

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